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Economics Decreasing return of scale and law of diminishing returns

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How should I proceed answering the question: Distinguish between decreasing returns to scale and the law of diminishing returns?

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Hi, 

 

Thanks King112 for the straightforward structure, I do agree with this. One additional point at the end would be real-life examples. 

 

As to the content of your answer: decreasing returns to scale happens on the upward sloping part of the long-run average total cost (LRATC) curve. This is when a company is "too big for its own good." If the company is very-very large it might have higher costs per unit if it further increases output e.g. due to problems of communication, or being regulated by the government. In such cases many large firms decide to spin off some areas of business (split off sections as separate companies). A proper definition of decreasing returns to scale is that an increase in the quantity of inputs (land and/or labour and/or capital) will produce a proportionally smaller increase in the quantity of output. Since all of the factors of production are variable, this happens in the long-run.

 

The law of diminishing returns states that as firms grow, adding additional units of variable resources (usually labour) to fixed resources (land, capital), there is going to be a point over which the productivity of these additional variable inputs decrease. In plain English, if you have a set number of machines and you are hiring more and more people, at first with each additional worker your output will grow proportionally more, but after a while the productivity of each additional employee will start to decrease it (e.g. workers are in the way of each other, or machines are working at or close to full capacity). Since only labour is a variable resource, whereas land and capital are fixed, this happens in the short-run (as opposed to the decreasing returns to scale phenomenon).

 

Hope this helps.

 

EconDaddy

IB Econmics tutor and examiner

www.econdaddy.com

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It's funny because I accidentally hit upon this subject this morning. Then, I had mock Econ paper1 and exactly that question was there. Tnaks guys! ;)

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